Use Tax: Definition, Example, and FAQs

What Is Use Tax?

Use tax is a type of consumption tax levied by a state on the purchase of goods or services from outside the state for use within the state, when sales tax was not collected by the seller. It falls under the broader category of Taxation and functions as a complementary tax to the sales tax. The primary purpose of use tax is to ensure fairness and prevent consumers from avoiding sales tax by purchasing goods from out-of-state retailers, particularly those without a physical presence in the consumer's jurisdiction. While the sales tax is typically collected by the retailer, the use tax is generally the responsibility of the consumer to self-assess and remit to the state.

History and Origin

The concept of use tax emerged in the early 20th century, particularly during the Great Depression, as states sought to protect their local economies and maintain government revenue amidst growing interstate commerce. Prior to the rise of e-commerce, the main challenge was regulating purchases made through mail-order catalogs from out-of-state vendors. The use tax was designed to level the playing field for in-state retailers who were required to collect sales tax, compared to out-of-state businesses that were not.²⁰, ²¹

For decades, the enforcement of use tax on out-of-state purchases was limited by the "physical presence" rule, established by Supreme Court cases like National Bellas Hess v. Department of Revenue of Illinois (1967) and Quill Corp. v. North Dakota (1992). These rulings stated that a state could only compel a business to collect sales or use tax if that business had a physical presence (e.g., offices, employees, or property) within the state.¹⁸, ¹⁹ This created a significant competitive advantage for remote sellers.

However, the landscape dramatically shifted with the U.S. Supreme Court's landmark decision in South Dakota v. Wayfair, Inc. in 2018. The Court overturned the physical presence rule, allowing states to require out-of-state sellers to collect sales and use tax if they meet certain economic thresholds (e.g., a minimum number of transactions or dollar amount of sales) in that state, regardless of physical presence.¹⁷ This ruling significantly changed tax compliance requirements for online sellers and reduced the scenarios where a consumer would owe use tax directly.

Key Takeaways

• Use tax is a consumption tax levied on purchases where sales tax was not collected by the seller, typically for out-of-state purchases.
• It serves as a complement to sales tax, aiming to create a fair competitive environment for in-state and out-of-state businesses.
• The responsibility for remitting use tax generally falls on the buyer, especially if the seller is not obligated to collect sales tax.
• The 2018 South Dakota v. Wayfair Supreme Court decision significantly expanded states' ability to require remote sellers to collect sales and use tax, reducing instances where consumers directly owe use tax.
• Non-compliance with use tax obligations can lead to penalties and interest.

Interpreting the Use Tax

Use tax is generally calculated at the same rate as the sales tax in the jurisdiction where the item is used or consumed. Its interpretation is straightforward: if you purchase a taxable item and no sales tax was charged by the vendor (often because they lack a nexus in your state or operate under an exemption), you are legally obligated as the taxpayer to report and pay the corresponding use tax. This ensures that all taxable consumption within a state contributes to its revenue, regardless of where the purchase originated.¹⁶

Hypothetical Example

Imagine Sarah, living in State A, wants to buy a specialized camera lens not readily available in her state. She finds an online retailer based in State B that doesn't have any physical presence or economic nexus (sales volume) in State A. As a result, when Sarah purchases the lens for $1,000, the retailer does not charge her State A's 6% sales tax.

Upon receiving the lens in State A, Sarah is now technically liable for the use tax. She would calculate the use tax as 6% of the purchase price:

Use Tax = Purchase Price × Use Tax Rate
Use Tax = $1,000 × 0.06
Use Tax = $60

Sarah would then be responsible for reporting and remitting this $60 use tax to State A's department of revenue, often through her annual income tax return or a separate filing. This ensures that the transaction, even though it involved interstate commerce, is still taxed at the same rate as if she had purchased it from a local store in State A.

Practical Applications

Use tax primarily applies to situations where a consumer or business acquires taxable goods or services without paying sales tax at the point of purchase. This frequently occurs with:

• Online and Mail-Order Purchases: Before the Wayfair decision, many online purchases from remote sellers did not include sales tax. Now, while many large online retailers collect sales tax in most states, smaller vendors or those not meeting a state's economic nexus threshold may still not collect it, shifting the use tax obligation to the buyer.
  *¹⁴, ¹⁵ Out-of-State Purchases: If a resident buys a large item, like furniture or a vehicle, in a neighboring state with no sales tax or a lower sales tax rate, and brings it back for use in their home state, use tax may apply.
• Business-to-Business (B2B) Transactions: Businesses often purchase supplies, equipment, or inventory from out-of-state vendors. If sales tax is not collected on these purchases, the business is responsible for self-assessing and paying the use tax. This is a significant area of tax compliance for companies.
  *¹³ Items Removed from Inventory for Business Use: A retailer might purchase items tax-free for resale (with an exemption certificate). If they later use some of these items for their own business operations (e.g., a computer store uses a display laptop as an office computer), use tax becomes due on the cost of that item.

Many states now explicitly require or provide a line on their individual income tax forms for residents to report and pay use tax, and businesses report it on their sales and use tax returns.

¹¹, ¹²## Limitations and Criticisms
Despite its legal basis and intended fairness, use tax faces significant limitations, primarily concerning its enforcement, especially for individual consumers. The vast number of transactions and the challenge of tracking individual purchases make comprehensive collection from consumers nearly impossible. This often leads to low compliance rates among individuals, relying largely on an "honor system."

¹⁰For businesses, while enforcement is more rigorous through audits, the complexity of identifying taxable goods, applying correct rates across numerous gross receipts and varying jurisdictions, and keeping meticulous records can be a substantial burden. C⁸, ⁹ritics argue that the administrative burden on taxpayers and the enforcement difficulties for states contribute to a significant amount of uncollected use tax revenue, potentially undermining the rule of law and general tax morale. T⁶, ⁷he fragmented nature of state tax laws, with over 13,000 sales and use tax jurisdictions in the U.S., further complicates accurate calculation and remittance for multi-state businesses and consumers alike.

⁴, ⁵## Use Tax vs. Sales Tax
While often discussed together and serving a similar function in public finance, use tax and Sales tax differ fundamentally in who is legally obligated to remit the tax and under what circumstances.

The primary confusion arises because both taxes aim to tax consumption. However, the use tax essentially captures the tax that would have been collected as sales tax had the transaction occurred fully within the state and involved a nexus-collecting seller. Its existence is crucial for preventing tax avoidance and ensuring equitable revenue collection.

FAQs

Q: Do I always owe use tax if I buy something online without paying sales tax?
A: Not necessarily. Following the South Dakota v. Wayfair Supreme Court decision, most large online retailers now collect sales tax for states where they meet economic nexus thresholds. If the retailer should have collected sales tax but didn't, you as the buyer are responsible for the use tax. If the retailer is genuinely not required to collect sales tax in your state, then the use tax obligation typically falls to you.

³Q: How do states know if I owe use tax?
A: For individual consumers, enforcement is challenging, often relying on self-reporting, typically through a line on your annual state income tax return. For businesses, states have more robust audit mechanisms and can sometimes obtain purchase records from vendors or third-party payment processors to verify compliance.

²Q: What happens if I don't pay use tax that I owe?
A: If a state discovers that you owe use tax and have not paid it, you could be subject to penalties, interest, and potentially further enforcement actions, similar to other unpaid tax liabilities. The exact consequences vary by state.¹